California's Latest Pay Plunder

Outrage over lavish salaries and pensions in Bell, California, could fire up reform in public compensation laws and practices.

Girard Miller is the Public Money columnist for GOVERNING and a senior strategist at the PFM Group.

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There's nothing like a government salary scandal to get people worked up. Last week the Los Angeles Times reported a doozie. Bell, California-a tiny working class city near Los Angeles that has a population of 36,000 and a median income under $30,000 — had paid their city manager nearly $800,000 a year.

To add insult to injury, the now-resigned official will likely receive a lifetime pension in the range of $700,000 a year plus CPI increases. That translates into a $30 million golden handshake, according to one report. And it wasn't just the city manager: The city manager's assistant and the police chief were also overpaid. Even the part-time city council members in this hamlet collect $100,000 a year. Needless to say, there is talk of a recall election to oust the council. Voters are not just crabby — they are fuming.

To pour gasoline on the fire, the unrepentant former city manager was quoted as claiming that he "could have easily earned that kind of money in the private sector." Well, I've worked as a CEO and COO for national firms, and there is nobody in that world who gets a salary of $787,000 plus a $30 million retirement package for running an organization of 80 workers performing commonplace tasks — unless they founded a closely held firm that developed a patented, high-margin product with customers worldwide. American companies with shareholders simply don't pay salaries that high to the managers of local service enterprises performing ordinary, replicable functions.

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Because the city participates in a pension pool with a hundred other small communities and subdivisions, the innocent taxpayers of those other municipalities may be stuck with the bills for part of these overpaid officials' outrageous lifetime pensions. So this problem is not confined to Bell's 2.5-square-mile territorial limits. The state's municipal league condemned the city's compensation practices. One prominent civic leader called the city salary arrangements and the mayor's posturing "nauseating."

Incidentally, this isn't the first such pay abuse in this region: the former Vernon, California city manager is smugly collecting a half-million dollar lifetime pension benefit that he parlayed through equivalent gamesmanship — even though he was indicted for embezzlement. There must be something potent in the water on that side of the metroplex.

To put this in perspective, the problem of excessive pay is hardly unique to local government. CEOs of bailed-out banks were lambasted last week by the federal pay czar. National nonprofit organizations underwent a decade of CEO pay scandals in the 1980s that forced significant tax-law reforms that awakened their boards of directors and changed their compensation practices for the better.

Demands for responsible reform. Already there are calls for new laws and reforms, although nobody has presented a concise solution for incidents like this. The League of California Cities is reportedly working on a legislative proposal to stop this kind of nonsense.

Amid the furor, however, there is a risk of overkill. This column will try to offer some balanced suggestions and discuss the issues and problems that will result from over-reacting and acting hastily. As with the BP incident in the Gulf, there are plenty of lessons to learn, but we need to act thoughtfully and not reactively.

Also, let me say that the vast majority of America's public officials and public employees are more likely to be underpaid, not overpaid. In thousands of communities across America, most public officials, public managers and millions of public servants earn every penny of salary they receive. We need to curb the extreme abuses and go no further. Otherwise our system will scare away everybody who's competent and dedicated to public service, and they will leave government work forever.

On the other hand, there might be an opportunity here to leverage the public outrage into viable long-term reforms. As Rahm Emanuel has said, "Never let a serious crisis go to waste." In that context, here are a few observations and suggestions for policy leaders to consider:

1. Sunshine is the best disinfectant. If anything proved the need to make public officials', union employees' and retirees' pay more visible to the public, this year's Bell incident and the now-notorious $100,000 CalPERS and county pension club revelations have succeeded. There should be no need to sue a pension fund to get that information. Fortunately the courts have agreed on that principle so far, but if we need to strengthen our freedom of information laws to assure public access without litigation, then so be it. I don't want to fuel petty witch hunts, but those in the public sector must know it's a goldfish bowl and accept that reality as the price of public service.

2. Full and fair disclosure. In the corporate world, the boards and top executives of public companies must disclose their total compensation in their public financial reports and shareholder proxy statements. Public managers who lust to play in the big leagues must be held to that same standard. Ironically, the Bell manager who bragged about fiscal stewardship and claims he belongs in the same league with the corporate execs didn't even post a public financial report on the city's website. Talk about duplicity and hypocrisy. Note that the federal financial reform laws now facilitate shareholder advisory votes on corporate executive compensation. Does anybody on that council really think the voters of Bell would have endorsed this guy's pay?

For the record, I truly don't think pay plebiscites are the answer. Management-by-lynch-mob would be the result. But good disclosure and an active media will curb abuses.

3. Pension caps and DC top-hats. We have to put a limit on public pensions, period. Illinois set a cap of $106,000 on pensions for new hires. In states where pensions of incumbents are protected constitutionally, that is the best we can do. But it's an approach to consider. Another remedy is to simply limit the amount of pay that can be used in the pension formula to a similar level in the low six figures. That, plus anti-spiking reforms, such as those embraced by gubernatorial candidate Jerry Brown, would curb both management and union abuses, for the benefit of all taxpayers. If employees deserve more for retirement, then employers should put it into a visible above-board defined-contribution plan so there are no hidden costs. This includes police and firefighters making six figures with overtime. If a city council wants to award its high-performing manager $25,000 or more in a good year for that year's retirement benefit, then so be it. But don't bury it in a fat pension that future taxpayers have to pay while it bypasses the current budget.

Transparent, disclosed supplemental retirement plans (called top-hat plans in the industry) must become more prevalent in state and local government. That would help avoid ridiculous pension annuities at levels that inflame the public, invite pension envy and induce nausea.

4. Public employment contract law. Not every state has the problems of California, so I don't recommend this nationwide. But the Golden State needs a law that forbids employment-related contracts awarding excessive compensation at all public agencies and municipalities. This approach would have faster impact than pension reforms which typically apply only to new hires. The law should provide for a claw-back of excessive compensation, plus interest and penalties. To avoid frivolous and spiteful litigation, there must be several protections: (1) the plaintiff(s) must file a bond [except prosecutors after satisfying a grand jury], (2) the loser must pay all costs including legal expenses, and (3) safe harbors should allow for reasonable publicly vetted compensation approved by a qualified independent committee or subcommittee of the governing board with independent validation — as performed in the corporate world and often in the highly compensated segment of the nonprofit sector.

To focus its scope and avoid overkill, this law should apply only to six-figure compensation, adjusted for inflation. It should apply to union contracts as well, so that taxpayers in cities like bankrupt Vallejo would have status to invalidate abusive union pay and pension deals.

Public-sector compensation should be evaluated against three market standards, which must all be satisfied. Public salaries in the six-figure bracket should not exceed:

• Prevailing local public-sector compensation for similar job titles

• Prevailing local (private-sector) labor market compensation for similar work, skills and services

• The "replacement cost" of similar personnel in the open market including the costs of training. Nobody in public service is irreplaceable, regardless of popularity or talent. So if a replacement city manager with viable experience could be recruited at far less cost, then compensation beyond the incumbent's replacement cost is potentially excessive, unless linked to objective performance-based accomplishments. Likewise, if six-figure firefighters can be replaced in the open labor market for 60 percent of the salaries paid those with seniority, something is awry.

If a public employer wishes to exceed these levels of salary compensation, the pay plan should require variable pay (bonuses or deferred compensation) based on personal performance against pre-established public goals, objectives and targets for accomplishment. Such individual performance incentives must be market-competitive and not cosmetic or "rigged." If unions want their workers to be paid "over the top," they must live with pay-for-performance and full public disclosure of prevailing pay rates as well. Variable awards for top management should be disclosed in public (the corporate model), and it would be generally reasonable to require full public disclosure of all others receiving such compensation in excess of 25 percent of base salary at the six-figure level. Remember, these would be only the folks who are known to be paid more than prevailing pay levels, so we're presumably dealing with outliers here.

A statute governing both management and union employees would protect the public's interest, especially if it includes clawback provisions (excessive compensation must be repaid to the employer). The law could require a special master to be appointed by the court when needed, so that technical factors are fairly evaluated. In the Bell case, such a clawback provision would now be worth millions of dollars to the local taxpayers who are sadly doomed to bear the burden of this scoundrel's pension costs for years to come. The risk of a clawback with penalties and costs would discourage abusers and sober up the decision process.

For public employers that pay within prevailing compensation rates, they are done once they complete their homework every contract renewal. For them, it's business-as-usual thereafter, under this due diligence system.

5. Professional ethical standards. The highly respected International City/County Management Association (ICMA) needs to review its ethical codes. The last thing their reputable professionals need is legislative overkill, relentless and overzealous investigative reporters, and further disincentive to work for the public — and that is where overkill for these notorious abuses will push the pendulum. But there must be a way for thoughtful professional associations to set peer standards for what constitutes fair pay. Better that they manage the process, than a lynch mob or a disingenuous legislature. After all, these are the people who say: "I Can Manage Anything."

ICMA (or its California state association) could carefully craft a guideline that requires "suitable professional" compensation above a prevailing salary level to take the form of performance bonuses, with limits on lifetime pensions, broader use of defined contribution plans for high-end retirement benefits, and full disclosure in the annual report to be published on the employer's Web site. Objective justification for compensation above prevailing levels should be documented by a professional, independent third party. That would meet the national corporate and non-profit "duty of care" and "duty of loyalty" standards that elected officials and chief administrators should respectively follow as guiding ethical principles.

The neighboring city managers promptly wrote a letter of outrage, but their reference to "do good and avoid evil" platitudes in their ICMA code of ethics informs us all that they need to put more substance into the warm-and-fuzzy guidance that has obviously flunked the test of reality in parts of southern California.

6. Labor arbitration laws must also be reformed as described in my prior column. What's good for the managerial goose must be equally good for the union ganders. The standards suggested in section #4 above would help stop pay abuses in those proceedings as well.

I realize that some of these ideas could spawn a cottage industry for compensation consultants. But my informed judgment is that the net cost to taxpayers will be less as a result — especially if these measures are thoughtfully implemented and required primarily in extremis. And for the record, I have no interest in taking on work in that field!

*This column includes a correction to a previous version, which stated that the city of Bell employs 200 workers. The city actually employs 80.